Alistair Darling knows it. Mervyn King knows it. The period of steady growth and low inflation that began in 1992 on the day that Britain was forced out of the exchange rate mechanism is over, and neither the chancellor nor the governor of the Bank of England needed last night's fourpenn'orth from the International Monetary Fund to tell them that these are difficult times.

Indeed, the IMF's health check on the UK only served to underline what Darling and King have been saying for some time. The combination of a credit crunch, a deflating housing bubble and spiralling food and energy prices means that the outlook for growth is much lower and inflation higher than the Treasury was forecasting in the spring budget. For the first time since it was elected in May 1997 Labour is beset by the sort of tough economic climate that was part of everyday life for Harold Wilson and Jim Callaghan in the 1960s and 1970s. For the first time since it was granted operational independence five days after Tony Blair's first landslide victory, the credibility of the Bank of England is at stake when it meets to decide interest rates today.

Creating the nine-strong monetary policy committee (MPC), and ceding to it the power to set the cost of borrowing, was seen as a masterstroke by Gordon Brown and for 10 years the liberated Bank had it easy. It was, as King put it, a "nice" decade of "non-inflationary continual expansion" in which globalisation helped keep prices low and output high. Monetary policy became a technocratic affair: the MPC experts giving the odd tweak here and there in order to hit the government's inflation target.

When the MPC met in August 2007, days before the credit crisis began, it spoke with one voice. All nine members said the rate should be left at 5.75% following five quarter-point increases, but the City was put on alert for further rises should the economy fail to slow. There was a reference to market tremors but nothing to suggest that August 9 2007 would end the recovery that began for the UK on September 16 1992.

Life has moved on. With the economy facing the twin perils of recession and inflation, last month's MPC meeting showed it was split three ways. One member, David Blanchflower, said lower rates were necessary to prevent Britain following the US into a housing market-led downturn. Blanchflower has been a lone voice on the MPC in recent months, but he is supported by economists who believe that higher food and fuel prices will ultimately prove deflationary rather than inflationary because of their impact on consumer spending power.

A former MPC member, Sushil Wadhwani, criticised the Bank yesterday for failing to "lean against the wind" when the housing market was booming out of control and for now failing to provide a parachute when the economy was coming rapidly back to earth.

Another MPC member, Tim Besley, sees things differently. He voted to raise rates last month on the grounds that it would signal that the Bank had gone soft on inflation if it ignored the fact that the government's target was being missed by an ever-wider margin. Besley takes the stitch-in-time approach: it is better to raise interest rates a little bit rather than risk having to raise them a lot later should inflation get out of control. The other seven members decided to let things be last month, though some share Blanchflower's concern about doing too little too late to prevent a recession and some would have joined Besley in voting for higher rates had they not feared taking the financial markets by surprise.

King knows his second term at the helm in Threadneedle Street, which began last month, will be more challenging than the first. At a press conference in May to launch the Bank's quarterly inflation report, he said: "The monetary policy committee is facing its most difficult challenge yet. For the time being, at least, the 'nice' decade is behind us. The credit cycle has turned. Commodity prices are rising. We are travelling along a bumpy road as the economy rebalances. Monetary policy cannot, and should not try to, prevent that adjustment."

King's message is that we must grin and bear it. Should wage bargainers seek compensation for higher inflation by securing higher pay deals, the Bank will push up interest rates. The threat - unspoken but real - is that the Bank will use higher unemployment to return inflation to its 2% target if it must.

The Bank's concern is that the government's preferred measure of inflation has been rising steadily over the past year, up from 1.8% last August to 3.8% last month, and is certain to go still higher as the 35% increase in domestic energy bills takes effect. City analysts believe the peak will be close to 5% this autumn.

If this scenario had been unfolding a year ago, the MPC would now be raising rates aggressively. Yet, as the IMF noted last night, Britain is in the grip of a credit crunch that has put intense strain on the financial markets, savaged the housing market and sharply reduced the outlook for growth. Most City analysts believe rates will stay on hold until later this year, by when inflation should have peaked. But lower interest rates take time to work - an uncomfortable prospect for a government 20 points behind in the polls and with an election less than two years away - and in the meantime the stimulus for the economy is coming from higher borrowing rather than cheaper borrowing. The IMF said last night that the UK would grow by 1.4% this year and 1.1% next: many City economists believe the outlook for 2009 is even worse than that.